May 11, 2018

What to do when no company meets all the investment checklist parameters? How to find equity dilution, loss on investments and equity contribution? (Q&A)


www.drvijaymalik.com has a section dedicated to answering queries from readers: “Ask Your Queries”. Over time, many readers have asked their queries related to many aspects of stock analysis and sought clarifications about investing. We have responded to these queries as replies to their comments.

“Q&A” series is an attempt to share the queries & their responses, which have featured on “Ask Your Queries” section, with all the readers. The primary aim of this new feature is to share the knowledge with other readers of the website, who might have similar queries.

The current article in this series provides responses related to the following queries:
  • What to do when no company meets all the investment checklist parameters?
  • How to find out if a company has diluted its equity in the past?
  • How to determine if a company has lost money on its investments?
  • How to determine equity contribution in Fund Flow Analysis?
When no company meets investment checklist parameters,
How to find equity dilution, loss on investments, determine equity contribution in Fund Flow Analysis?


What to do when no company meets all the investment checklist parameters?


Dr Vijay. 

I read your e-book “Peaceful Investing: A Simple Guide to Hassle-free Investing”. It is a very nice work.

I am a new investor. I have some basic query:

For investments, it is very difficult for a single company to fulfill all parameter in the checklist.

(Further advised reading: Final Checklist for Buying Stocks)

So please let me know your priority or the percentage weight on the parameters, which are most important and the parameters where you believe that some compromises can be made.

If you have written an article on it, then please let me know.


Author’s Response:


Hi,

Thanks for writing to us!

In case, an investor is not able to find any company, which meets all the parameters and the investor still wishes to make investments by relaxing the selection parameters, then we usually advise investors to follow the following approach:

Out of the key analysis parameters: financial, business, valuation, management and operating efficiency parameters, if the investor wishes to relax, then the parameter, which may be relaxed is the valuation parameter. Retaining all other parameters indicates that the companies, which the investor will consider for investment, will have good fundamentals.

However, an investor should keep in mind that by relaxing the valuation parameter, i.e. by investing at the higher price (high P/E ratio); the probabilities of future returns would be lower. Therefore, it may happen that the business of the company is doing good but the stock price is not moving higher because it had already reached a very high level when the investor initially purchased the stock.

An investor should read the below article to understand the risks that she may face when she invests in companies at a high valuation.



Therefore, an investor needs to tone down her future return expectations accordingly when she invests in stocks at a high price.

Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik


How to find out if a company has diluted its equity in the past?



Dear Vijay,

How do we know if a company has been diluting or is diluting its equity? I mean which data point should we look at to determine if equity dilution is happening and if yes, by how much?

In your excel template, we have "Share Capital". If it increases by 20% this year with respect to last year, does it mean equity dilution has happened and its magnitude is 20%? And similarly, reverse with buyback?

If you can provide an example, it will be helpful.

Thanks


Author’s Response:


Hi,

Thanks for writing to us!

You are right that the dilution of equity, as well as its extent, is measured by the way of increase in share capital (paid-up share capital). The share capital of any company increases because of following activities: 
  1. Issuance of new shares either by way of IPO/FPO/preferential allotment/exercise of ESOPs/warrants etc. All these actions lead to equity dilution because when these new shares are issued by the company for allotment to entities in such transactions, then the percentage shareholding of existing shareholders reduces.
  2. Issuance of bonus shares. This action does not lead to dilution as all the existing shareholders get an equal proportion of new shares so the percentage shareholding of all the promoters remains the same both before and after the issuance of bonus shares.


The share capital decreases because of buyback of shares.


Therefore, it becomes important that an investor should keep monitoring the changes in the paid-up share capital and in case there is an increase in any period, then she should check the annual report to find out, if it was due to issuance of new shares (dilution) or issuance of bonus shares (non-dilution).

All the best for your investing journey!

Regards

Dr. Vijay Malik


How to determine if a company has lost money on its investments?




Excellent analysis by you!

Point no 5 in the above analysis: Invested in Arihantsidh Properties Pvt. Ltd in 2016 whose value reduced to 600,000 and in 2017, it is written off. They did the same in 2013 too.

Does it mean that invested amount is not collectible or that investment was sold off?

If it was sold off, then the amount received should be shown in accounts under which heading?


Author’s Response:


Hi,

Thanks for writing to us!

Writing off an investment indicates that the investment is non-collectible. In such cases, the companies show "Provisions" for diminution of value of investments in the annual report. This entry would be found on both the balance sheet as well as the profit and loss statement. In the balance sheet, the provision will be shown in the non-current assets, where the details of the original investments are shown. In the profit and loss statement, the provision will be shown in the "other expenses".

In case, the company has sold off the investment, then the company will show the amount received in the cash flow statement as an inflow under the segment “cash flow from investments” (CFI) section. Alongside, in the profit and loss statement, the company will show gain or losses on the sale of investment most of the times in the "other income" section. Many times, the losses might be shown in the "Other expenses" as well.


Hope it answers your queries.

All the best for your investing journey!

Regards

Dr. Vijay Malik


How to determine equity contribution in Fund Flow Analysis?



Hi Dr. Malik,

I learned fund flow analysis from your class in Bangalore and I am trying to implement it for KRBL Ltd. However, I am unable to figure out which number needs to be used when calculating "Equity". Should we be using:
  1. The difference between last year's equity and current year's equity or
  2. PAT for the current year to come to a conclusion?

I have attached an image of my analysis for your perusal. Any help would be much appreciated :-)

Regards,

Author’s Response:


Hi,

Thanks for writing to us!

In the case of fund flow analysis, while comparing the balance sheet of two years, we use the difference in the Equity (equity is the sum of equity capital and reserves & surplus).


The change in equity would be a result of retained earnings (PAT - dividend including dividend distribution tax) and other sources like equity raising due to IPO/FPO etc. or equity reduction due to buybacks etc.

We cannot use PAT straightaway in fund flow analysis because as mentioned above, a few other things other than PAT would also impact equity: like dividend distribution, equity raising or equity reduction etc.

All the best for your investing journey!

Regards

Dr. Vijay Malik


P.S:
  • To know about the stocks in our portfolio, their relative composition, cost price, details of all our buy/sell transactions since August 1, 2017 as well as to get updates about any future buy/sell transaction in our portfolio, you may subscribe to the premium service: Follow My Portfolio with Latest Buy/Sell Transactions Updates (Premium Service)
  • To learn our stock investing approach “Peaceful Investing” in detail at any time & place of your convenience, you may subscribe to “Peaceful Investing” Workshop-on-Demand, which allows subscribers to watch the recorded videos (9h:30m) of a complete full-day “Peaceful Investing” workshop. You can watch the FREE Sample Video (16min) of the workshop where we have discussed the basics of balance sheet along with fund flow analysis and read about other details of this premium service at the following page: “Peaceful Investing” Workshop-on-Demand
  • The excel template that we use in our stock analysis is now, compatible with screener.in. This customized Excel template is now available for download as a premium feature. For further details and download Click Here
  • You may learn more about our stock analysis approach in the e-book: “Peaceful Investing – A Simple Guide to Hassle-free Stock Investing”
  • You may read more company analyses based on our stock investing approach in the Company Analysis e-book series spread across multiple volumes: Click Here
  • To register for the "Peaceful Investing" workshop to be held in New Delhi on May 13, 2018: Click Here
  • To register for the "Peaceful Investing" workshop to be held in Mumbai on July 29, 2018: Click Here
  • To pre-register/express interest for a “Peaceful Investing” workshop in your city: Click here
  • Subscribe to email updates at our website to get the FREE e-book: "Case Studies: Applying Peaceful Investing Approach"



DISCLAIMER


Registration Status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:

Currently, I do not own stocks of any of the companies discussed above